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Contents vii
The Yield Curve and the Economy 154 6.5 Sovereign Bonds 192
n Common Mistake Using the n Global Financial Crisis The
Annuity Formula When Discount Credit Crisis and Bond Yields 193
Rates Vary by Maturity 154 n Global Financial Crisis
n Interview with European Sovereign Debt Yields:
Kevin M. Warsh 156 A Puzzle 195
5.4 Risk and Taxes 157 n Interview with
Risk and Interest Rates 158 Carmen M. Reinhart 196
After-Tax Interest Rates 159 MyFinanceLab 197 n Key Terms 198 n
5.5 The Opportunity Cost of Capital 160 Further Reading 199 n Problems 199 n
n Common Mistake States Dig Data Case 203 n Case Study 204
a $3 Trillion Hole by Discounting Appendix Forward Interest Rates 206
at the Wrong Rate 161 Computing Forward Rates 206
MyFinanceLab 162 n Key Terms 163 n Computing Bond Yields from Forward
Further Reading 163 n Problems 163 n Rates 207
Data Case 168
Appendix Continuous Rates
and Cash Flows 170 Part 3 V
aluing Projects
Discount Rates for a Continuously and Firms
Compounded APR 170
Continuously Arriving Cash Flows 170
Chapter 7 Investment Decision Rules 212
7.1 NPV and Stand-Alone
Chapter 6 Valuing Bonds 173 Projects 213
6.1 Bond Cash Flows, Prices, Applying the NPV Rule 213
and Yields 174 The NPV Profile and IRR 213
Bond Terminology 174 Alternative Rules Versus the NPV
Zero-Coupon Bonds 174 Rule 214
n Global Financial Crisis n Interview with Dick Grannis 215
Negative Bond Yields 176 7.2 The Internal Rate of Return Rule 216
Coupon Bonds 177 Applying the IRR Rule 216
6.2 Dynamic Behavior of Bond Prices 179 Pitfall #1: Delayed Investments 216
Discounts and Premiums 179 Pitfall #2: Multiple IRRs 217
Time and Bond Prices 180 n Common Mistake
Interest Rate Changes and Bond IRR Versus the IRR Rule 219
Prices 182 Pitfall #3: Nonexistent IRR 219
n Clean and Dirty Prices for Coupon
7.3 The Payback Rule 220
Bonds 183
Applying the Payback Rule 220
6.3 The Yield Curve and Bond
Payback Rule Pitfalls in Practice 221
Arbitrage 185
n Why Do Rules Other Than the NPV
Replicating a Coupon Bond 185
Rule Persist? 222
Valuing a Coupon Bond Using Zero-Coupon
Yields 186 7.4 Choosing Between Projects 222
Coupon Bond Yields 187 NPV Rule and Mutually Exclusive
Investments 222
Treasury Yield Curves 188
IRR Rule and Mutually Exclusive
6.4 Corporate Bonds 188 Investments 223
Corporate Bond Yields 189 The Incremental IRR 224
n Are Treasuries Really Default-Free n When Can Returns Be
Securities? 189 Compared? 225
Bond Ratings 191 n Common Mistake
Corporate Yield Curves 192 IRR and Project Financing 227
A01_BERK3278_04_SE_FM.indd 7 6/11/16 9:07 PM

viii Contents
7.5 Project Selection with Resource MyFinanceLab 264 n Key Terms 266 n
Constraints 227 Further Reading 266 n Problems 266 n
Evaluating Projects with Different Data Case 273
Resource Requirements 227
Appendix MACRS Depreciation 275
Profitability Index 228
Shortcomings of the Profitability
Index 230 Chapter 9 Valuing Stocks 277
MyFinanceLab 230 n Key Terms 231 n 9.1 The Dividend-Discount Model 278
Further Reading 231 n Problems 231 n A One-Year Investor 278
Data Case 237 Dividend Yields, Capital Gains, and Total
Returns 279
Appendix Computing the NPV Profile Using
Excel’s Data Table Function 238 n The Mechanics of a Short Sale 280
A Multiyear Investor 281
Chapter 8 Fundamentals of Capital The Dividend-Discount Model
Equation 282
Budgeting 239
9.2 Applying the Dividend-Discount
8.1 Forecasting Earnings 240 Model 282
Revenue and Cost Estimates 240 Constant Dividend Growth 282
Incremental Earnings Forecast 241 Dividends Versus Investment
Indirect Effects on Incremental and Growth 283
Earnings 243 n John Burr Williams’ Theory
n Common Mistake The Opportunity of Investment Value 284
Cost of an Idle Asset 244 Changing Growth Rates 286
Sunk Costs and Incremental Limitations of the Dividend-Discount
Earnings 245 Model 288
n Common Mistake 9.3 Total Payout and Free Cash Flow
The Sunk Cost Fallacy 245 Valuation Models 288
Real-World Complexities 246 Share Repurchases and the Total Payout
8.2 Determining Free Cash Flow Model 288
and NPV 247 The Discounted Free Cash
Calculating Free Cash Flow Flow Model 290
from Earnings 247 9.4 Valuation Based on Comparable
Calculating Free Cash Flow Directly 249 Firms 294
Calculating the NPV 250 Valuation Multiples 294
n USING EXCEL Capital Budgeting Limitations of Multiples 296
Using a Spreadsheet Program 251 Comparison with Discounted Cash Flow
8.3 Choosing Among Alternatives 252 Methods 297
Evaluating Manufacturing Stock Valuation Techniques: The Final
Alternatives 252 Word 298
Comparing Free Cash Flows for Cisco’s n Interview with Douglas Kehring 299
Alternatives 253 9.5 Information, Competition, and Stock
8.4 Further Adjustments to Free Prices 300
Cash Flow 254 Information in Stock Prices 300
n Global Financial Crisis Competition and Efficient Markets 301
The American Recovery and Lessons for Investors and Corporate
Reinvestment Act of 2009 258 Managers 303
8.5 Analyzing the Project 258 n Kenneth Cole Productions—What
Break-Even Analysis 258 Happened? 305
Sensitivity Analysis 259 The Efficient Markets Hypothesis Versus
No Arbitrage 306
n Interview with David Holland 261
Scenario Analysis 262 MyFinanceLab 306 n Key Terms 308 n
n USING EXCEL Project Analysis Further Reading 308 n Problems 309 n
Using Excel 263 Data Case 314

Contents ix
Part 4 Risk and Return Chapter 11 Optimal Portfolio Choice

and the Capital Asset Pricing
Chapter 10 Capital Markets and the Pricing Model 357
of Risk 318 11.1 The Expected Return of a
Portfolio 358
10.1 Risk and Return: Insights from 89 Years
of Investor History 319 11.2 The Volatility of a Two-Stock
Portfolio 359
10.2 Common Measures of Risk
and Return 322 Combining Risks 359
Probability Distributions 322 Determining Covariance
and C orrelation 360
Expected Return 322
n Common Mistake
Variance and Standard Deviation 323
Computing Variance, Covariance,
10.3 Historical Returns of Stocks and Correlation in Excel 362
and Bonds 325 Computing a Portfolio’s Variance
Computing Historical Returns 325 and Volatility 363
Average Annual Returns 327 11.3 The Volatility of a Large Portfolio 365
The Variance and Volatility of Large Portfolio Variance 365
Returns 329
Diversification with an Equally Weighted
Estimation Error: Using Past Returns Portfolio 366
to Predict the Future 330
n Interview with John Powers 368
n Arithmetic Average Returns Versus
Diversification with General
Compound Annual Returns 332
Portfolios 369
10.4 The Historical Trade-Off Between Risk
11.4 Risk Versus Return: Choosing
and Return 332
an Efficient Portfolio 369
The Returns of Large Portfolios 333
Efficient Portfolios with Two Stocks 370
The Returns of Individual Stocks 334
The Effect of Correlation 372
10.5 Common Versus Independent Risk 335 Short Sales 373
Theft Versus Earthquake Insurance: Efficient Portfolios with Many
An Example 335 Stocks 374
The Role of Diversification 336 n Nobel Prizes Harry Markowitz
10.6 Diversification in Stock and James Tobin 375
Portfolios 337 11.5 Risk-Free Saving and Borrowing 377
Firm-Specific Versus Systematic Risk 338 Investing in Risk-Free Securities 377
No Arbitrage and the Risk Borrowing and Buying Stocks
Premium 339 on M
argin 378
n Global Financial Crisis Identifying the Tangent Portfolio 379
Diversification Benefits During
Market Crashes 341 11.6 The Efficient Portfolio and Required
n Common Mistake A Fallacy Returns 381
of Long-Run Diversification 342 Portfolio Improvement: Beta
and the R equired Return 381
10.7 Measuring Systematic Risk 343
Expected Returns and the Efficient
Identifying Systematic Risk: The Market Portfolio 383
Portfolio 343
Sensitivity to Systematic Risk: Beta 343 11.7 The Capital Asset Pricing Model 385
The CAPM Assumptions 385
10.8 Beta and the Cost of Capital 346
Supply, Demand, and the Efficiency
Estimating the Risk Premium 346
of the Market Portfolio 386
n Common Mistake
Optimal Investing: The Capital
Beta Versus Volatility 346
Market Line 386
The Capital Asset Pricing Model 348
11.8 Determining the Risk Premium 387
MyFinanceLab 348 n Key Terms 350 n Market Risk and Beta 387
Further Reading 350 n Problems 350 n n Nobel Prize William Sharpe
Data Case 355 on the CAPM 389

x Contents
The Security Market Line 390 12.7 Final Thoughts on Using

Beta of a Portfolio 390 the CAPM 430
Summary of the Capital Asset MyFinanceLab 431 n Key Terms 433 n
Pricing Model 392 Further Reading 433 n Problems 434 n
MyFinanceLab 392 n Key Terms 395 n Data Case 438
Further Reading 395 n Problems 396 n Appendix Practical Considerations When
Data Case 402 Forecasting Beta 439
Appendix The CAPM with Differing Time Horizon 439
Interest Rates 404 The Market Proxy 439
The Efficient Frontier with Differing Saving Beta Variation and Extrapolation 439
and Borrowing Rates 404 Outliers 440
The Security Market Line with Differing n Common Mistake Changing
Interest Rates 404 the Index to Improve the Fit 441
n USING EXCEL Estimating Beta
Using Excel 442
Chapter 12 Estimating the Cost Other Considerations 443
of Capital 407
12.1 The Equity Cost of Capital 408 Chapter 13 Investor Behavior and Capital
12.2 The Market Portfolio 409 Market Efficiency 445
Constructing the Market Portfolio 409
Market Indexes 409 13.1 Competition and Capital Markets 446
n Value-Weighted Portfolios and Identifying a Stock’s Alpha 446
Rebalancing 410 Profiting from Non-Zero Alpha Stocks 447
The Market Risk Premium 411 13.2 Information and Rational
12.3 Beta Estimation 413 Expectations 448
Using Historical Returns 413 Informed Versus Uninformed
Investors 448
Identifying the Best-Fitting Line 415
Rational Expectations 449
Using Linear Regression 416
n Why Not Estimate Expected Returns 13.3 The Behavior of Individual
Directly? 417 Investors 450
Underdiversification and Portfolio
12.4 The Debt Cost of Capital 417
Biases 450
Debt Yields Versus Returns 417
Excessive Trading and
n Common Mistake Using the Debt Overconfidence 451
Yield as Its Cost of Capital 418
Individual Behavior and Market
Debt Betas 419 Prices 453
12.5 A Project’s Cost of Capital 420 13.4 Systematic Trading Biases 453
All-Equity Comparables 420 Hanging on to Losers and the
Levered Firms as Comparables 421 Disposition Effect 453
The Unlevered Cost of Capital 421 n Nobel Prize Kahneman and
Industry Asset Betas 423 Tversky’s Prospect Theory 454
12.6 Project Risk Characteristics Investor Attention, Mood,
and Financing 425 and Experience 454
Differences in Project Risk 425 Herd Behavior 455
n Common Mistake Adjusting Implications of Behavioral
for Execution Risk 427 Biases 455
Financing and the Weighted Average Cost 13.5 The Efficiency of the Market
of Capital 427 Portfolio 456
n Interview with Shelagh Glaser 428 Trading on News or
n COMMON MISTAKE Recommendations 456
Using a Single Cost of Capital n Nobel Prize The 2013 Prize:
in Multi-Divisional Firms 429 An Enigma? 458

Contents xi
The Performance of Fund Managers 458 Computing the WACC with Multiple
The Winners and Losers 461 Securities 502
Levered and Unlevered Betas 502
13.6 Style-Based Techniques and the Market
Efficiency Debate 462 n Nobel Prize Franco Modigliani
and Merton Miller 504
Size Effects 462
n Interview with 14.4 Capital Structure Fallacies 505
Jonathan C
lements 464 Leverage and Earnings per Share 505
Momentum 466 n GLOBAL Financial Crisis
n Market Efficiency and the Efficiency Bank Capital Regulation and
of the Market Portfolio 467 the ROE Fallacy 507
Implications of Positive-Alpha Trading Equity Issuances and Dilution 508
Strategies 467 14.5 MM: Beyond the Propositions 509
13.7 Multifactor Models of Risk 469 MyFinanceLab 510 n Key Terms 511 n
Using Factor Portfolios 470 Further Reading 511 n Problems 512 n
Selecting the Portfolios 471 Data Case 516
The Cost of Capital with Fama-French-
Carhart Factor Specification 472
13.8 Methods Used in Practice 474 Chapter 15 Debt and Taxes 519
Financial Managers 474
15.1 The Interest Tax Deduction 520
Investors 475
15.2 Valuing the Interest Tax Shield 522
MyFinanceLab 476 n Key Terms 478 n The Interest Tax Shield and Firm
Further Reading 478 n Problems 479 Value 522
Appendix Building a Multifactor Model 485 n Pizza and Taxes 523
The Interest Tax Shield with Permanent
Debt 523
The Weighted Average Cost of Capital
Part 5 Capital Structure with Taxes 524
n The Repatriation Tax: Why Some
Chapter 14 Capital Structure in a Perfect Cash-Rich Firms Borrow 525
Market 488 The Interest Tax Shield with a Target
Debt-Equity Ratio 526
14.1 Equity Versus Debt Financing 489
Financing a Firm with Equity 489 15.3 Recapitalizing to Capture the Tax
Shield 528
Financing a Firm with Debt
and Equity 490 The Tax Benefit 528
The Effect of Leverage on Risk The Share Repurchase 529
and Return 491 No Arbitrage Pricing 529
14.2 Modigliani-Miller I: Leverage, Arbitrage, Analyzing the Recap: The Market Value
and Firm Value 493 Balance Sheet 530
MM and the Law of One Price 493 15.4 Personal Taxes 531
Homemade Leverage 493 Including Personal Taxes in the Interest
n MM and the Real World 494 Tax Shield 531
The Market Value Balance Sheet 495 Valuing the Interest Tax Shield
with Personal Taxes 534
Application: A Leveraged
Recapitalization 496 Determining the Actual Tax Advantage
of Debt 535
14.3 Modigliani-Miller II: Leverage, Risk,
n Cutting the Dividend Tax Rate 535
and the Cost of Capital 498
Leverage and the Equity Cost 15.5 Optimal Capital Structure
of Capital 498 with Taxes 536
Capital Budgeting and the Weighted Do Firms Prefer Debt? 536
Average Cost of Capital 499 Limits to the Tax Benefit of Debt 539
n Common Mistake n Interview with
Is Debt Better Than Equity? 502 Andrew Balson 540

xii Contents
Growth and Debt 541 Reduction of Wasteful Investment 572

Other Tax Shields 542 n Excessive Perks and Corporate
The Low Leverage Puzzle 542 Scandals 573
n Employee Stock Options 544 n Global Financial Crisis
Moral Hazard, Government Bailouts,
MyFinanceLab 544 n Key Terms 545 n and the Appeal of Leverage 574
Further Reading 545 n Problems 546 n Leverage and Commitment 575
Data Case 550
16.7 Agency Costs and the Trade-Off
Theory 575
Chapter 16 Financial Distress, The Optimal Debt Level 576
Managerial Incentives, Debt Levels in Practice 577
and Information 551 16.8 Asymmetric Information and C apital
16.1 Default and Bankruptcy in a Perfect Structure 577
Market 552 Leverage as a Credible Signal 577
Armin Industries: Leverage and the Risk Issuing Equity and Adverse
of Default 552 Selection 579
Bankruptcy and Capital Structure 553 n Nobel Prize The 2001 Nobel Prize
in Economics 581
16.2 The Costs of Bankruptcy and F inancial
Distress 554 Implications for Equity Issuance 581
The Bankruptcy Code 555 Implications for Capital Structure 582
Direct Costs of Bankruptcy 555 16.9 Capital Structure: The Bottom
Indirect Costs of Financial Line 585
Distress 556 MyFinanceLab 586 n Key Terms 588 n
n Global Financial Crisis Further Reading 588 n Problems 588
The Chrysler Prepack 559
16.3 Financial Distress Costs and Firm
Value 560
Chapter 17 Payout Policy 597
Armin Industries: The Impact of Financial 17.1 Distributions to Shareholders 598
Distress Costs 560 Dividends 598
Who Pays for Financial Distress Share Repurchases 600
Costs? 560
17.2 Comparison of Dividends and Share
16.4 Optimal Capital Structure: The
Repurchases 601
Trade-Off Theory 562
Alternative Policy 1: Pay Dividend
The Present Value of Financial
with Excess Cash 601
Distress Costs 562
Alternative Policy 2: Share Repurchase
Optimal Leverage 563
(No Dividend) 602
16.5 Exploiting Debt Holders: The Agency n Common Mistake Repurchases
Costs of Leverage 565 and the Supply of Shares 604
Excessive Risk-Taking and Asset Alternative Policy 3: High Dividend
Substitution 565 (Equity Issue) 604
Debt Overhang and Under-Investment 566 Modigliani-Miller and Dividend Policy
n Global Financial Crisis Irrelevance 605
Bailouts, Distress Costs, and Debt n Common Mistake The Bird
Overhang 567 in the Hand Fallacy 606
Agency Costs and the Value Dividend Policy with Perfect Capital
of Leverage 568 Markets 606
The Leverage Ratchet Effect 569
17.3 The Tax Disadvantage
Debt Maturity and Covenants 570
of Dividends 606
n Why Do Firms Go Bankrupt? 570
Taxes on Dividends and Capital
16.6 Motivating Managers: The Agency Gains 607
Benefits of Leverage 571 Optimal Dividend Policy
Concentration of Ownership 572 with Taxes 608

Contents xiii
17.4 Dividend Capture and Tax Valuing Equity Cash Flows 653
Clienteles 610 n What Counts as “Debt”? 654
The Effective Dividend Tax Rate 610 Summary of the Flow-to-Equity
Tax Differences Across Investors 611 Method 654
Clientele Effects 612 18.5 Project-Based Costs
n Interview with John Connors 613 of Capital 655
17.5 Payout Versus Retention of Cash 615 Estimating the Unlevered Cost
Retaining Cash with Perfect Capital of Capital 656
Markets 616 Project Leverage and the Equity Cost
Taxes and Cash Retention 617 of Capital 656
Adjusting for Investor Taxes 618 Determining the Incremental Leverage
Issuance and Distress Costs 619 of a Project 658
Agency Costs of Retaining Cash 620 n Common Mistake
Re-Levering the WACC 658
17.6 Signaling with Payout Policy 622
18.6 APV with Other Leverage
Dividend Smoothing 622 Policies 660
Dividend Signaling 623 Constant Interest Coverage Ratio 660
n Royal & SunAlliance’s Predetermined Debt Levels 661
Dividend Cut 624
A Comparison of Methods 663
Signaling and Share Repurchases 624
18.7 Other Effects of Financing 663
17.7 Stock Dividends, Splits,
and Spin-Offs 626 Issuance and Other Financing Costs 663
Stock Dividends and Splits 626 Security Mispricing 664
Spin-Offs 628 Financial Distress and Agency Costs 665
n Berkshire Hathaway’s n Global Financial Crisis
A & B Shares 629 Government Loan Guarantees 666
MyFinanceLab 630 n Key Terms 631 n

18.8 Advanced Topics in Capital
Budgeting 666
Further Reading 632 n Problems 632 n
Periodically Adjusted Debt 667
Data Case 636
Leverage and the Cost of Capital 669
The WACC or FTE Method with Changing
Leverage 671
Part 6 Advanced Valuation Personal Taxes 672
Chapter 18 Capital Budgeting and MyFinanceLab 674 n Key Terms 676 n

Valuation with Leverage 640 Further Reading 676 n Problems 677 n
Data Case 683
18.1 Overview of Key Concepts 641 Appendix Foundations and Further Details 685
18.2 The Weighted Average Cost Deriving the WACC Method 685
of Capital Method 642 The Levered and Unlevered
n INTERVIEW with Zane Rowe 643 Cost of Capital 686
Using the WACC to Value a Project 644 Solving for Leverage and Value
Summary of the WACC Method 645 Simultaneously 687
Implementing a Constant Debt-Equity The Residual Income and Economic Value
Ratio 646 Added Valuation Methods 689
18.3 The Adjusted Present Value Method 648 Chapter 19 Valuation and Financial
The Unlevered Value of the Project 648
Modeling: A Case Study 691
Valuing the Interest Tax Shield 649
Summary of the APV Method 650 19.1 Valuation Using Comparables 692
18.4 The Flow-to-Equity Method 652 19.2 The Business Plan 694
Calculating the Free Cash Flow Operational Improvements 694
to Equity 652 Capital Expenditures: A Needed

xiv Contents
Expansion 695 20.3 Put-Call Parity 736

Working Capital Management 696 20.4 Factors Affecting Option Prices 739
Capital Structure Changes: Levering Up 696 Strike Price and Stock Price 739
19.3 Building the Financial Model 697 Arbitrage Bounds on Option Prices 739
Forecasting Earnings 697 Option Prices and the Exercise Date 739
n Interview with Option Prices and Volatility 740
Joseph L. Rice, III 698 20.5 Exercising Options Early 741
Working Capital Requirements 700 Non-Dividend-Paying Stocks 741
Forecasting Free Cash Flow 701 Dividend-Paying Stocks 743
n USING EXCEL 20.6 Options and Corporate Finance 745
Summarizing Model Outputs 703
Equity as a Call Option 745
The Balance Sheet and Statement
Debt as an Option Portfolio 746
of Cash Flows (Optional) 704
Credit Default Swaps 746
n USING EXCEL
Auditing Your Financial Model 706 n Global Financial Crisis
Credit Default Swaps 747
19.4 Estimating the Cost of Capital 707
Pricing Risky Debt 748
CAPM-Based Estimation 707
Agency Conflicts 749
Unlevering Beta 708
Ideko’s Unlevered Cost of Capital 708 MyFinanceLab 750 n Key Terms 751 n

19.5 Valuing the Investment 709
Data Case 756
The Multiples Approach to Continuation
Value 710
The Discounted Cash Flow Approach
to Continuation Value 711 Chapter 21 Option Valuation 757
n Common Mistake Continuation
21.1 The Binomial Option Pricing
Values and Long-Run Growth 713
Model 758
APV Valuation of Ideko’s Equity 713
A Two-State Single-Period Model 758
A Reality Check 714
The Binomial Pricing Formula 760
n Common Mistake
A Multiperiod Model 761
Missing Assets or Liabilities 714
Making the Model Realistic 765
IRR and Cash Multiples 715
21.2 The Black-Scholes Option Pricing
19.6 Sensitivity Analysis 716
Model 766
MyFinanceLab 717 n Key Terms 718 n The Black-Scholes Formula 766
Further Reading 718 n Problems 719 n Interview with
Appendix Compensating Management 721 Myron S. Scholes 767
Implied Volatility 772
n Global Financial Crisis
The VIX Index 773
Part 7 Options
The Replicating Portfolio 774
Chapter 20 Financial Options 724 21.3 Risk-Neutral Probabilities 776

A Risk-Neutral Two-State Model 776
20.1 Option Basics 725 Implications of the Risk-Neutral
Understanding Option Contracts 725 World 776
Interpreting Stock Option Quotations 725 Risk-Neutral Probabilities and Option
Options on Other Financial Securities 727 Pricing 777
20.2 Option Payoffs at Expiration 728 21.4 Risk and Return of an Option 779
Long Position in an Option Contract 728 21.5 Corporate Applications of Option
Short Position in an Option Contract 729 Pricing 781
Profits for Holding an Option Beta of Risky Debt 781
to Expiration 731 n Common Mistake
Returns for Holding an Option Valuing Employee Stock Options 784
to Expiration 732 n Nobel Prize The 1997 Nobel Prize
Combinations of Options 733 in Economics 785

Contents xv
Agency Costs of Debt 785 Venture Capital Investing 834

Venture Capital Financing Terms 836
Further Reading 788 n Problems 788 n Common Mistake Misinterpreting
Start-Up Valuations 836
n From Launch to Liquidity 838
Exiting an Investment in a Private
Chapter 22 Real Options 793 Company 840
22.1 Real Versus Financial Options 794 23.2 The Initial Public Offering 840
22.2 Decision Tree Analysis 794 Advantages and Disadvantages
of Going Public 840
Representing Uncertainty 795
Types of Offerings 841
Real Options 796
The Mechanics of an IPO 843
Solving Decision Trees 796
n Google’s IPO 843
22.3 The Option to Delay: Investment
as a Call Option 797 23.3 IPO Puzzles 848
An Investment Option 797 Underpricing 848
n Why Are There Empty Lots in Built-Up Cyclicality 851
Areas of Big Cities? 800 n Global Financial Crisis
Factors Affecting the Timing Worldwide IPO Deals
of Investment 801 in 2008–2009 852
Investment Options and Firm Risk 802 Cost of an IPO 852
n Global Financial Crisis Long-Run Underperformance 853
Uncertainty, Investment, and 23.4 The Seasoned Equity Offering 854
the Option to Delay 803 The Mechanics of an SEO 854
22.4 Growth and Abandonment Price Reaction 856
Options 804 Issuance Costs 857
Valuing Growth Potential 804
The Option to Expand 806
n Interview with
Scott Mathews 807 Data Case 863
The Option to Abandon 808
22.5 Investments with Different Lives 810 Chapter 24 Debt Financing 865
n Equivalent Annual Benefit
24.1 Corporate Debt 866
Method 811
Public Debt 866
22.6 Optimally Staging Investments 812
Private Debt 870
22.7 Rules of Thumb 815 24.2 Other Types of Debt 871
The Profitability Index Rule 816 Sovereign Debt 871
The Hurdle Rate Rule 816 Municipal Bonds 873
n The Option to Repay a Mortgage 818 n Detroit’s Art Museum at Risk 873
22.8 Key Insights from Real Options 819 Asset-Backed Securities 874
MyFinanceLab 819 n Key Terms 821 n n Global Financial Crisis
CDOs, S ubprime Mortgages,
Further Reading 821 n Problems 821
and the Financial Crisis 874
24.3 Bond Covenants 876
Part 8 Long-Term Financing 24.4 Repayment Provisions 877
Call Provisions 877
Chapter 23 Raising Equity Capital 828 n New York City Calls Its Municipal
Bonds 879
23.1 Equity Financing for Private Sinking Funds 881
Companies 829
Convertible Provisions 881
Sources of Funding 829
n Crowdfunding: The Wave MyFinanceLab 883 n Key Terms 884 n
of the Future? 830 Further Reading 885 n Problems 885 n
n Interview with Kevin Laws 831 Data Case 886

xvi Contents
Chapter 25 Leasing 889 26.4 Payables Management 927

Determining Accounts Payable Days
25.1 The Basics of Leasing 890 Outstanding 927
Examples of Lease Transactions 890 Stretching Accounts Payable 928
Lease Payments and Residual
26.5 Inventory Management 928
Values 891
Benefits of Holding Inventory 929
Leases Versus Loans 892
Costs of Holding Inventory 929
n Calculating Auto Lease
Payments 893 26.6 Cash Management 930
End-of-Term Lease Options 893 Motivation for Holding Cash 930
Other Lease Provisions 895 Alternative Investments 931
25.2 Accounting, Tax, and Legal n Hoarding Cash 931
Consequences of Leasing 895
Lease Accounting 896
n Operating Leases at Alaska
Data Case 938
Air Group 897
The Tax Treatment of Leases 898
Leases and Bankruptcy 899
n Synthetic Leases 900 Chapter 27 Short-Term Financial
25.3 The Leasing Decision 900
Planning 941
Cash Flows for a True Tax Lease 901 27.1 Forecasting Short-Term Financing
Lease Versus Buy (An Unfair Needs 942
Comparison) 902 Seasonalities 942
Lease Versus Borrow (The Right Negative Cash Flow Shocks 945
Comparison) 903 Positive Cash Flow Shocks 946
Evaluating a True Tax Lease 905
27.2 The Matching Principle 947
Evaluating a Non-Tax
Lease 906 Permanent Working Capital 947
Temporary Working Capital 947
25.4 Reasons for Leasing 906
Financing Policy Choices 948
Valid Arguments for Leasing 907
n Interview with Mark Long 909 27.3 Short-Term Financing with Bank
Loans 949
Suspect Arguments for Leasing 910
Single, End-of-Period Payment
MyFinanceLab 911 n Key Terms 912 n Loan 949
Further Reading 912 n Problems 913 Line of Credit 949
Bridge Loan 950
Common Loan Stipulations
Part 9 Short-Term Financing and Fees 950
27.4 Short-Term Financing with Commercial
Chapter 26 Working Capital Paper 952
Management 918 n Global Financial Crisis
Short-Term Financing in Fall 2008 953
26.1 Overview of Working Capital 919
27.5 Short-Term Financing with Secured
The Cash Cycle 919 Financing 954
Firm Value and Working Capital 921 Accounts Receivable as Collateral 954
26.2 Trade Credit 922 n A Seventeenth-Century Financing
Trade Credit Terms 922 Solution 954
Trade Credit and Market Frictions 922 Inventory as Collateral 955
Managing Float 923 n Loan Guarantees: The Ex-Im Bank
26.3 Receivables Management 924 Controversy 956
Determining the Credit Policy 924 MyFinanceLab 957 n Key Terms 958 n
Monitoring Accounts Receivable 925 Further Reading 958 n Problems 959

Contents xvii
Part 10 Special Topics Chapter 29 Corporate Governance 993

29.1 Corporate Governance and Agency
Chapter 28 Mergers and Acquisitions 962 Costs 994
29.2 Monitoring by the Board of Directors

28.1 Background and Historical
and Others 995
Trends 963
Types of Directors 995
Merger Waves 963
Board Independence 995
Types of Mergers 965
Board Size and Performance 997
28.2 Market Reaction to a Takeover 965 Other Monitors 997
28.3 Reasons to Acquire 966 29.3 Compensation Policies 998

Economies of Scale and Scope 967 Stock and Options 998
Vertical Integration 967 Pay and Performance Sensitivity 998
Expertise 967 29.4 Managing Agency Conflict 1000
Monopoly Gains 968 Direct Action by Shareholders 1000
Efficiency Gains 968 n Shareholder Activism at The New
Tax Savings from Operating Losses 969 York Times 1001
Diversification 970 Management Entrenchment 1002
Earnings Growth 970 The Threat of Takeover 1003
Managerial Motives to Merge 971
29.5 Regulation 1003
28.4 Valuation and the Takeover The Sarbanes-Oxley Act 1004
Process 972 n Interview with
Valuation 973 Lawrence E. Harris 1005
The Offer 974 The Cadbury Commission 1006
Merger “Arbitrage” 975 Dodd-Frank Act 1007
Tax and Accounting Issues 976 Insider Trading 1007
Board and Shareholder Approval 977 n Martha Stewart and ImClone 1008
28.5 Takeover Defenses 978 29.6 Corporate Governance Around

the World 1008
Poison Pills 978
Protection of Shareholder Rights 1008
Staggered Boards 979
Controlling Owners and Pyramids 1009
White Knights 980
The Stakeholder Model 1011
Golden Parachutes 981
Cross-Holdings 1012
Recapitalization 981
Other Defensive Strategies 981 29.7 The Trade-Off of Corporate
Regulatory Approval 982 Governance 1013
n Weyerhaeuser’s Hostile Bid MyFinanceLab 1013 n Key Terms 1015 n
for Willamette Industries 982
28.6 Who Gets the Value Added
from a Takeover? 983
The Free Rider Problem 983 Chapter 30 Risk Management 1017
Toeholds 984
The Leveraged Buyout 984 30.1 Insurance 1018
n The Leveraged Buyout of RJR-Nabisco The Role of Insurance:
by KKR 985 An Example 1018
The Freezeout Merger 987 Insurance Pricing in a
Perfect Market 1018
Competition 988
The Value of Insurance 1020
MyFinanceLab 988 n Key Terms 990 n The Costs of Insurance 1022
Further Reading 990 n Problems 990 The Insurance Decision 1024

xviii Contents
30.2 Commodity Price Risk 1024 31.2 Valuation of Foreign Currency

Hedging with Vertical Integration Cash Flows 1061
and Storage 1025 WACC Valuation Method in Domestic
Hedging with Long-Term Contracts 1025 Currency 1062
Hedging with Futures Contracts 1027 Using the Law of One Price
n Common Mistake as a Robustness Check 1064
Hedging Risk 1029 31.3 Valuation and International
n Differing Hedging Strategies 1030 Taxation 1065
Deciding to Hedge Commodity Single Foreign Project with Immediate
Price Risk 1030 Repatriation of Earnings 1066
30.3 Exchange Rate Risk 1031 Multiple Foreign Projects and Deferral
Exchange Rate Fluctuations 1031 of Earnings Repatriation 1066
Hedging with Forward Contracts 1032 31.4 Internationally Segmented Capital
Cash-and-Carry and the Pricing Markets 1067
of Currency Forwards 1033 Differential Access to Markets 1067
n Global Financial Crisis Macro-Level Distortions 1068
Arbitrage in Currency Markets? 1035 Implications 1069
Hedging with Options 1037
31.5 Capital Budgeting with Exchange
30.4 Interest Rate Risk 1041
Risk 1070
Interest Rate Risk Measurement:
n Interview with Bill Barrett 1071
Duration 1041
Duration-Based Hedging 1043 MyFinanceLab 1073 n Key Terms 1074 n
Swap-Based Hedging 1046 Further Reading 1074 n Problems 1075 n
n The Savings and Loan Crisis 1048 Data Case 1077
Glossary 1079
Chapter 31 International Corporate
Finance 1059
31.1 Internationally Integrated Capital
Markets 1060 Index 1099

Bridging Theory
and Practice
GLO BAL FINANCIAL CRISIS European Sovereign Debt Yields: A Puzzle Focus on the Financial Crisis and Sovereign
Before the EMU created the euro as a single European cur- countries would be fiscally responsible and manage their
rency, the yields of sovereign debt issued by European coun-
tries varied widely. These variations primarily reflected
debt obligations to avoid default at all costs. But as illus-
trated by Figure 6.6, once the 2008 financial crisis revealed
Debt Crisis
differences in inflation expectations and currency risk (see the folly of this assumption, debt yields once again diverged
Figure 6.6). However, after the monetary union was put in
place at the end of 1998, the yields all essentially converged to
as investors acknowledged the likelihood that some coun-
tries (particularly Portugal and Ireland) might be unable to
Global Financial Crisis boxes reflect the reality of the recent
the yield on German government bonds. Investors seemed to
conclude that there was little distinction between the debt of
repay their debt and would be forced to default.
In retrospect, rather than bringing fiscal responsibility, financial crisis and ongoing sovereign debt crisis, noting lessons
the European countries in the union––they seemed to feel that the monetary union allowed the weaker member countries
all countries in the union were essentially exposed to the same to borrow at dramatically lower rates. In response, these learned. Twenty-two boxes across the book illustrate and
default, inflation and currency risk and thus equally “safe.” countries reacted by increasing their borrowing––and at
Presumably, investors believed that an outright default
was unthinkable: They apparently believed that member
least in Greece’s case, borrowed to the point that default
became inevitable.
analyze key details.
The Law of One Price as the Unifying

Valuation Framework
The Law of One Price framework reflects the modern idea that
the absence of arbitrage is the unifying concept of valuation. This
critical insight is introduced in Chapter 3, revisited in each part
opener, and integrated throughout the text—motivating all major
concepts and connecting theory to practice.
Study Aids with a Practical Focus

COMMON MISTAKE Discounting One Too Many Times
The perpetuity formula assumes that the first payment away and then the cash flows are periodic. From the per-
occurs at the end of the first period (at date 1). Sometimes spective of date 1, this is a perpetuity, and we can apply the
perpetuities have cash flows that start later in the future. In formula. From the preceding calculation, we know we need To be successful, students need to master the core concepts and
this case, we can adapt the perpetuity formula to compute $375,000 on date 1 to have enough to start the parties on
the present value, but we need to do so carefully to avoid a
common mistake.
date 2. We rewrite the timeline as follows: learn to identify and solve problems that today’s practitioners face.
To illustrate, consider the MBA graduation party
described in Example 4.7. Rather than starting immedi-
0 1 2 3
... Common Mistakes boxes alert students to frequently made
ately, suppose that the first party will be held two years from
today (for the current entering class). How would this delay
change the amount of the donation required?
$375,000 $30,000 $30,000
mistakes stemming from misunderstanding core concepts and
Now the timeline looks like this: Our goal can now be restated more simply: How much do
we need to invest today to have $375,000 in one year? This
calculations—in the classroom and in the field.
0 1 2 3 is a simple present value calculation:
...
$30,000 $30,000
PV = $375,000/1.08 = $347,222 today
A common mistake is to discount the $375,000 twice
We need to determine the present value of these cash flows, because the first party is in two periods. Remember—the EXAMPLE 4.14 Evaluating an Annuity with Monthly Cash Flows
as it tells us the amount of money in the bank needed today present value formula for the perpetuity already discounts the
to finance the future parties. We cannot apply the perpetuity cash flows to one period prior to the first cash flow. Keep in Problem
formula directly, however, because these cash flows are not mind that this common mistake may be made with perpetu- You are about to purchase a new car and have two options to pay for it. You can pay $20,000 in
exactly a perpetuity as we defined it. Specifically, the cash ities, annuities, and all of the other special cases discussed in Worked Examples cash immediately, or you can get a loan that requires you to pay $500 each month for the next
48 months (four years). If the monthly interest rate you earn on your cash is 0.5%, which option
flow in the first period is “missing.” But consider the situ- this section. All of these formulas discount the cash flows to
ation on date 1—at that point, the first party is one period one period prior to the first cash flow. accompany every im- should you take?
Solution
portant concept using a Let’s start by writing down the timeline of the loan payments:
1 2 48
step-by-step procedure 0 $500 $500
...
$500
that guides students The timeline shows that the loan is a 48-period annuity. Using the annuity formula the present
value is
through the solution PV (48@period annuity of $500) = $500 *

1
0.005
¢1 -
1
1.00548
≤
Kevin M. Warsh, a lecturer at Stanford’s

I N T E RV I E W W I T H
clarity and confidence in the financial
process. Clear labels = $21,290
Alternatively, we may use the annuity spreadsheet to solve the problem:
Graduate School of Business and a
distinguished visiting fellow at the Hoover
KEVIN M. WARSH wherewithal of each other. One effective,
innovative tool, the Term Auction Facility
make them easy to find Given
NPER
48
RATE
0.50%
PV PMT
500
FV
0
Excel Formula
Institution, was a Federal Reserve governor

from 2006 to 2011, serving as chief liaison
(TAF), stimulated the economy by pro-
viding cheap and readily available term
for help with home- Solve for PV (21,290) PV(0.005,48,500,0)
Thus, taking the loan is equivalent to paying $21,290 today, which is costlier than paying cash.
to the financial markets. funding to banks, large and small, on the
front lines of the economy, thus encour- work and studying. You should pay cash for the car.
aging them to extend credit to businesses

QUESTION: What are the main policy and consumers. After reducing the
instruments used by central banks to control policy rate to near zero to help revive the
the economy? economy, the Fed instituted two Quan-
titative Easing (QE) programs––special
ANSWER: The Federal Reserve (Fed)
deploys several policy tools to achieve its
purchases of government and agency
securities––to increase money supply,
Applications that Reflect Real Practice
goals of price stability, maximum sustain- promote lending, and according to some
able employment, and financial stability.
Lowering the federal funds short-term
proponents, increase prices of riskier
assets.
Corporate Finance features actual companies and leaders in the field.
interest rate, the primary policy instrument, The Fed also addressed the global
stimulates the economy. Raising the federal funds rate gener-
ally slows the economy. Buying and selling short-term U.S.
financial crisis by establishing temporary central bank
liquidity swap lines with the European Central Bank and
Interviews with notable practitioners—six new for this edi-
Treasury securities through open market operations is standard
practice. Prior to the 2007–2009 financial crisis, the Fed’s
other major central banks. Using this facility, a foreign
central bank is able to obtain dollar funding for its custom-
tion—highlight leaders in the field and address the effects of the
balance sheet ranged from $700–$900 billion. But when
the Fed was unable to lower interest rates further because
ers by swapping Euros for dollars or another currency and
agreeing to reverse the swap at a later date. The Fed does financial crisis.
rates were so close to zero already, it resorted to large-scale, not take exchange rate risk, but it is subject to the credit
longer-term open market operations to increase liquidity in
the financial system in the hopes of stimulating the economy
risk of its central bank counterparty. General Interest boxes highlight timely material from financial
further, thus growing its balance sheet significantly. With
open mouth operations, the Fed’s announcements of its intent
QUESTION: What tools is the European Central Bank
(ECB) using to address the sovereign debt crisis? How does its publications that shed light on business problems and real-
to buy or sell assets indicates its desired degree of future
policy accommodation, often prompting markets to react
approach compare to the Fed’s approach to the 2007–2009
financial crisis? company practices.
by adjusting interest rates immediately. The Fed’s Lender-of-
Last-Resort authority allows it to lend money against good ANSWER: As a novel economic federation, the ECB
collateral to troubled institutions under certain conditions. finds itself in a more difficult position than the Fed. The
underlying economies and competitiveness are mark-
QUESTION: What factors limit the effectiveness of Fed policy? edly different across the Eurozone—in Germany versus
Greece, for example. From 2007 until mid-2010, many
xix
ANSWER: Monetary policy does not act in isolation. Fiscal European financiers and policymakers believed that global
(taxing and spending), trade, and regulatory policies have financial crisis was largely American-made, with some
huge consequence on the state of economic and financial strains exported to the continent. By mid-2010, however,
conditions. In the short term, monetary policy can help they recognized that it was indeed a global crisis. The
buy time for an economy to improve, but it cannot cure ECB is formally charged with a single mandate of ensur-
structural failings of an economy in isolation or compen- ing price stability, rather than the broader mandate of the
sate for the country’s growing indebtedness. Fed. Still, its actions ultimately mirrored many of those
undertaken by the Fed: lowering the effective policy rate
QUESTION: What tools did the Fed create to address the
to record lows, providing direct liquidity to the Eurozone’s
2007–2009 financial crisis?
financial institutions to avoid a potential run on the bank-
ANSWER: During the darkest days of the crisis, markets ing system, and instituting the Security Market Purchase
did not operate effectively, prices for securities did not program (buying sovereign credit of some of its distressed
A01_BERK3278_04_SE_FM.indd
clear, and banks and 19
other financial institutions lacked countries). 6/11/16 9:07 PM
Teaching Students
to Think Finance
With a consistency in presentation and an innovative set of learning aids, Corporate Finance simultaneously meets the needs of
both future financial managers and non-financial managers. This textbook truly shows every student how to “think finance.”
Simplified Presentation of Mathematics

One of the hardest parts of learning finance is mastering the
jargon, math, and non-standardized notation. Corporate Finance
systematically uses:
USING EXCEL Excel also has a built-in function, IRR, that will calculate the IRR of a stream of cash flows.
Notation Boxes: Each chapter opens by defining the variables Excel’s IRR Function
Excel’s IRR function has the format, IRR (values, guess), where “values” is the range containing
the cash flows, and “guess” is an optional starting guess where Excel begins its search for an IRR.
and acronyms used in the chapter as a “legend” for students’ See the example below:
reference.
Timelines: Introduced in Chapter 4, timelines are emphasized
as the important first step in solving every problem that There are three things to note about the IRR function. First, the values given to the IRR func-
tion should include all of the cash flows of the project, including the one at date 0. In this
involves cash flows. sense, the IRR and NPV functions in Excel are inconsistent. Second, like the NPV function, the
IRR ignores the period associated with any blank cells. Finally, as we will discuss in Chapter 7,
Numbered and Labeled Equations: The first time a full equa- in some settings the IRR function may fail to find a solution, or may give a different answer,
depending on the initial guess.
tion is given in notation form it is numbered. Key equations

are titled and revisited in the chapter summary.
Using Excel Boxes: Provide hands-on instruction of Excel
techniques and include screenshots to serve as a guide for students.
Spreadsheet Tables: Select tables are available as Excel files, TABLE 8.1
SPREADSHEET
HomeNet’s Incremental Earnings Forecast
enabling students to change inputs and manipulate the under-

Year 0 1 2 3 4 5
lying calculations. Incremental Earnings Forecast ($000s)
1 Sales — 26,000 26,000 26,000 26,000 —
2 Cost of Goods Sold — (11,000) (11,000) (11,000) (11,000) —
3 Gross Profit — 15,000 15,000 15,000 15,000 —
4 Selling, General, and Administrative — (2,800) (2,800) (2,800) (2,800) —
5 Research and Development (15,000) — — — —
6 Depreciation — (1,500) (1,500) (1,500) (1,500) (1,500)
7 EBIT (15,000) 10,700 10,700 10,700 10,700 (1,500)
8 Income Tax at 40% 6,000 (4,280) (4,280) (4,280) (4,280) 600
9 Unlevered Net Income (9,000) 6,420 6,420 6,420 6,420 (900)
Practice Finance to Learn Finance

Working problems is the proven way to cement and demonstrate
an understanding of finance.
Concept Check questions at the end of each section enable
students to test their understanding and target areas in which
they need further review.
End-of-chapter problems written personally by Jonathan
Data Case This is your second interview with a prestigious brokerage firm for a job as an equity analyst. You
Berk and Peter DeMarzo offer instructors the opportunity survived the morning interviews with the department manager and the Vice President of Equity.
Everything has gone so well that they want to test your ability as an analyst. You are seated in a room
to assign first-rate materials to students for homework and with a computer and a list with the names of two companies—Ford (F) and Microsoft (MSFT). You
have 90 minutes to complete the following tasks:
1. Download the annual income statements, balance sheets, and cash flow statements for the last
practice with the confidence that the problems are consistent four fiscal years from MarketWatch (www.morningstar.com). Enter each company’s stock symbol
and then go to “financials.” Export the statements to Excel by clicking the export button.
with chapter content. Both the problems and solutions, which 2. Find historical stock prices for each firm from Yahoo! Finance (finance.yahoo.com). Enter your
stock symbol, click “Historical Prices” in the left column, and enter the proper date range to
also were written by the authors, have been class-tested and cover the last day of the month corresponding to the date of each financial statement. Use the
closing stock prices (not the adjusted close). To calculate the firm’s market capitalization at each
accuracy-checked to ensure quality.

date, multiply the number of shares outstanding (see “Basic” on the income statement under
“Weighted Average Shares Outstanding”) by the firm’s historic stock price.
3. For each of the four years of statements, compute the following ratios for each firm:
Data Cases present in-depth scenarios in a business setting Valuation Ratios

Price-Earnings Ratio (for EPS use Diluted EPS Total)
with questions designed to guide students’ analysis. Many Market-to-Book Ratio

Enterprise Value-to-EBITDA
(For debt, include long-term and short-term debt; for cash, include marketable securities.)
questions involve the use of Internet resources and Excel Profitability Ratios
Operating Margin
techniques. Net Profit Margin
Return on Equity
xx

MyFinanceLab
Because practice with homework problems is crucial to learning finance, Corporate Finance is available with ,a
fully integrated homework and tutorial system. revolutionizes homework and practice with material written and
developed by Jonathan Berk and Peter DeMarzo.
Online Assessment Using End-of-Chapter Problems n End-of-chapter problems—every single one

The seamless integration among the textbook, assessment materials, —appear online. The values in the problems are
and online resources sets a new standard in corporate finance algorithmically generated, giving students many
education. opportunities for practice and mastery. Problems
can be assigned by professors and completed
online by students.
n Helpful tutorial tools, along with the same peda-
gogical aids from the text, support students as they
study. Links to the eText direct students right to
the material they most need to review.
n Interactive Figures—Select in-text graphs and
figures—covering topics such as bonds, stock
valuation, NPV, and IRR—have been digitally
enhanced to allow students to interact with vari-
ables to affect outcomes and bring concepts to life.
Additional Resources in
n Video clips profile high-profile firms such as
Boeing, Cisco, Delta, and Intel through interviews
14. You have been offered a unique investment opportunity. If you invest $10,000 today, you will and analysis. The videos focus on core topical
receive $500 one year from now, $1500 two years from now, and $10,000 ten years from now.
a. What is the NPV of the opportunity if the interest rate is 6% per year? Should you take the areas, including capital budgeting, mergers and
opportunity?
b. What is the NPV of the opportunity if the interest rate is 2% per year? Should you take it now? acquisitions, and risk and return.
n Auto-Graded Excel Projects—Using proven,
field-tested technology, ’s new auto-
graded Excel Projects allow instructors to seam-
lessly integrate Excel content into their course.
n Finance in the News provides weekly postings of
a relevant and current article from a newspaper or
journal article with discussion questions that are
assignable in .
n Live news and video feeds from The Financial
Times and ABC News provide real-time news
updates.
n Author Solution Videos walk through the in-text
examples using math, the financial calculator, and
spreadsheets.
To learn more about ,

contact your local Pearson representative,
www.pearsoneducation.com/replocator,
or visit www.myfinancelab.com.
xxi

Hands-On Practice,
Hands-Off Grading
Hands-On, Targeted Practice
Students can take pre-built Practice Tests
for each chapter, and their test results will
generate an individualized Study Plan.
With the Study Plan, students learn to
focus their energies on the topics they need
to be successful in class, on exams, and,
ultimately, in their careers.
Powerful Instructor Tools

provides flexible tools that
enable instructors to easily customize the
online course materials to suit their needs.
n Easy-to-Use Homework Manager.
Instructors can easily create and assign
tests, quizzes, or graded homework
assignments. In addition to pre-built
questions, the Test Bank
is also available so that instructors have
ample material with which to create
assignments.
n Flexible Gradebook. saves time by automatically grading students’
work and tracking results in an online Gradebook.
n Downloadable Classroom Resources. Instructors also have access to online
versions of each instructor supplement, including the Instructor’s Manual,
Solutions Manual, PowerPoint Lecture Notes, and Test Bank.
To learn more about , contact your local Pearson representative,

www.pearsoneducation.com/replocator, or visit www.myfinancelab.com.
xxii

About the Authors
Jonathan Berk is the A.P. Giannini Professor of Finance at the Graduate School of Busi-
ness, Stanford University and is a Research Associate at the National Bureau of Economic
Research. Before coming to Stanford, he was the Sylvan Coleman Professor of Finance at
Haas School of Business at the University of California, Berkeley. Prior to earning his Ph.D.,
he worked as an Associate at Goldman Sachs (where his education in finance really began).
Professor Berk’s research interests in finance include corporate valuation, capital struc-
ture, mutual funds, asset pricing, experimental economics, and labor economics. His work
has won a number of research awards including the TIAA-CREF Paul A. Samuelson Award,
the Smith Breeden Prize, Best Paper of the Year in The Review of Financial Studies, and the
FAME Research Prize. His paper, “A Critique of Size-Related Anomalies,” was selected as
one of the two best papers ever published in The Review of Financial Studies. In recognition
of his influence on the practice of finance he has received the Bernstein-Fabozzi/Jacobs Levy
Award, the Graham and Dodd Award of Excellence, and the Roger F. Murray Prize. He
served two terms as an Associate Editor of the Journal of Finance,
and a term as a director of the American Finance Association,
the Western Finance Association, and academic director of
the Financial Management Association. He is a Fellow of the
Financial Management Association and a member of the advi-
sory board of the Journal of Portfolio Management.
Born in Johannesburg, South Africa, Professor Berk is mar-
ried, with two daughters, and is an avid skier and biker.
Peter DeMarzo is the Mizuho Financial Group Professor of

Finance at the Graduate School of Business, Stanford University.
He is the current Vice President of the American Finance Asso-
ciation and a Research Associate at the National Bureau of Eco-
Peter DeMarzo and Jonathan Berk
nomic Research. He teaches MBA and Ph.D. courses in Corporate
Finance and Financial Modeling. In addition to his experience at the Stanford Graduate School
of Business, Professor DeMarzo has taught at the Haas School of Business and the Kellogg
Graduate School of Management, and he was a National Fellow at the Hoover Institution.
Professor DeMarzo received the Sloan Teaching Excellence Award at Stanford and the
Earl F. Cheit Outstanding Teaching Award at U.C. Berkeley. Professor DeMarzo has served
as an Associate Editor for The Review of Financial Studies, Financial Management, and the
B.E. Journals in Economic Analysis and Policy, as well as a director of the American Finance
Association. He has served as Vice President and President of the Western Finance Associa-
tion. Professor DeMarzo’s research is in the area of corporate finance, asset securitization,
and contracting, as well as market structure and regulation. His recent work has examined
issues of the optimal design of contracts and securities, leverage dynamics and the role of
bank capital regulation, and the influence of information asymmetries on stock prices and
corporate investment. He has received numerous awards including the Western Finance
Association Corporate Finance Award and the Barclays Global Investors/Michael Brennan
best-paper award from The Review of Financial Studies.
Professor DeMarzo was born in Whitestone, New York, and is married with three boys.
He and his family enjoy hiking, biking, and skiing.
xxiii

Preface
W
E WERE MOTIVATED TO WRITE THIS TEXTBOOK BY A CENTRAL
insight: The core concepts in finance are simple and intuitive. What makes the
subject challenging is that it is often difficult for a novice to distinguish between
these core ideas and other intuitively appealing approaches that, if used in financial decision
making, will lead to incorrect decisions. De-emphasizing the core concepts that underlie
finance strips students of the essential intellectual tools they need to differentiate between
good and bad decision making.
We present corporate finance as an application of a set of simple, powerful ideas. At the
heart is the principal of the absence of arbitrage opportunities, or Law of One Price—in
life, you don’t get something for nothing. This simple concept is a powerful and important
tool in financial decision making. By relying on it, and the other core principles in this
book, financial decision makers can avoid the bad decisions brought to light by the recent
financial crisis. We use the Law of One Price as a compass; it keeps financial decision
makers on the right track and is the backbone of the entire book.
New to This Edition

We have updated all text discussions and figures, tables, data cases, and facts to accurately
reflect developments in the field in the last four years. Specific highlights include the
following:
n Increased coverage of early stage financing in Chapter 23 (Raising Equity Capital),
including a detailed explanation of angel financing, venture capital deal terms, and an
expanded explanation of typical returns investors might earn.
n Addressed the implications of negative interest rates throughout the book.
n Expanded coverage of the European debt crisis in Chapter 6 (Valuing Bonds) including
a case study on the Greek default.
n Added material throughout Part 5 (Capital Structure) that relates the capital structure
to the current debate on bank leverage.
n Added coverage in Chapter 1 (The Corporation) describing the ongoing changes to
how stocks are traded worldwide.
n Expanded the explanation of key financial ratios in Chapter 2 (Introduction to Finan-
cial Statement Analysis) and index arbitrage in Chapter 3 (Financial Decision Making
and the Law of One Price).
n Redesigned sections of Chapter 22 (Real Options) with new examples to make the
exposition clearer.
n Updated the coverage in Chapter 13 (Investor Behavior and Capital Market Efficiency)
to reflect recent developments in asset pricing.
n Six new practitioner interviews incorporate timely perspectives from leaders in the field
related to the recent financial crisis and ongoing European sovereign debt crisis.
n Added Nobel Prize boxes to reflect the recent Nobel Prizes awarded for material covered
in the book.
n Added a new Case Study, two new Data Cases, new problems and refined many others,
once again personally writing and solving each one. In addition, every single problem
is available in , the groundbreaking homework and tutorial system that
accompanies the book.
xxiv

Another random document with
no related content on Scribd:
who come here now. No news from Hendryx or
Lewis. Quite a number going out after wood to cook
with. Hot and wet.
June 4.—Have not been dry for many days.
Raining continually. Some men took occasion while
out after wood, to overpower the guard and take to
the pines. Not yet been brought back. Very small
rations of poor molasses, corn bread and bug soup.
June 5.—Exchange rumors to the effect that
transports are en-route for Savannah for the purpose
of taking us home. Stick right to my washing
however. A number of men taken out to be kept as
hostages—so said. Raiders rule the prison. Am
myself cross and feel like licking somebody, but
Hendryx is gone and don’t want to try to lick anybody
else, fearing I might get licked myself. Some fun
fighting him as it didn’t make any difference which
licked.
June 6.—Eight months a prisoner to-day. A lifetime
has been crowded into these eight months. No
rations at all. Am now a hair cutter. Have hired the
shears. Enough to eat but not the right kind. Scurvy
putting in its work, and symptoms of dropsy. Saw
Hendryx at the bake house up stairs window, looking
over the camp. Probably looking to see if he can
locate his old comrades among the sea of human
beings. Wirtz comes inside no more, in fact, does
very few rebels. The place is too bad for them.
June 7.—Heard to-day that Hendryx had been
arrested and in irons for inciting a conspiracy. Not
much alarmed for him. He will come out all right. Still
rainy. Have hard work keeping my diary dry. Nearly
all the old prisoners who were captured with me are
dead. Don’t know of over 50 or 60 alive out of 800.
F R O M B A D TO W O R S E .
THE ASTOR HOUSE MESS STILL HOLDS TOGETHER, ALTHOUGH

DEPLETED—ALL MORE OR LESS DISEASED—AS THE
WEATHER GETS WARMER THE DEATH RATE INCREASES—
DYING OFF LIKE SHEEP—THE END IS NOT YET.
June 8.—More new prisoners. There are now over

23,000 confined here, and the death rate 100 to 130
per day, and I believe more than that. Rations worse.
June 9.—It is said that a grand break will occur
soon, and nearly the whole prison engaged in the
plot. Spies inform the rebels of our intentions. Rains
yet.
June 10.—The whole camp in a blaze of
excitement. Plans for the outbreak known to Capt.
Wirtz. Some traitor unfolded the plans to him. Thirty
or forty pieces of artillery pointed at us from the
outside, and stockade covered with guards who
shoot right and left. Thirty or forty outsiders sent
inside, and they tell us how the affair was found out.
A number of the ringleaders are undergoing
punishment. Hendryx has made his escape, and not
been heard of since yesterday. It is said he went
away in full Confederate dress, armed, and furnished
with a guide to conduct him. Dr. Lewis died to-day.
Jack Walker told us about his death. Capt. Wirtz has
posted up on the inside a notice for us to read. The
following is the notice:
“NOTICE.
Not wishing to shed the blood of hundreds
not connected with those who concocted a
plan to force the stockade, and make in this
way their escape. I hereby warn the leaders
and those who formed themselves into a
band to carry out this, that I am in
possession of all the facts, and have made
my arrangements accordingly, so to frustrate
it. No choice would be left me but to open
with grape and cannister on the stockade,
and what effect this would have in this
densely crowded place need not be told.
Signed,
H. Wirtz.”
June 10, 1864.
June 11.—And so has ended a really colossal

attempt at escape. George Hendryx was one of the
originators of the plan. He took advantage of the
excitement consequent upon its discovery and made
good his escape, and I hope will succeed in getting
to our lines. It is the same old situation here only
worse, and getting worse all the time. I am not very
good at description, and find myself at fault in writing
down the horrible condition we are in.
June 12.—Rained every day so far this month. A
portion of the camp is a mud hole, and the men are
obliged to lay down in it. Fort Pillow prisoners tell
some hard stories against the Confederacy at the
treatment they received after their capture. They
came here nearly starved to death, and a good many
were wounded after their surrender. They are mostly
Tennesseeans, and a “right smart sorry set.” Battese
has taken quite a fatherly interest in me. Keeps right
on at the head of the washing and hair cutting
business, paying no attention to anything outside of
his work. Says: “We get out all right!”
June 13.—It is now as hot and sultry as it was ever
my lot to witness. The cloudy weather and recent
rains make everything damp and sticky. We don’t any
of us sweat though, particularly, as we are pretty well
dried up. Laying on the ground so much has made
sores on nearly every one here, and in many cases
gangrene sets in and they are very bad off. Have
many sores on my body, but am careful to keep away
the poison. To-day saw a man with a bullet hole in his
head over an inch deep, and you could look down in
it and see maggots squirming around at the bottom.
Such things are terrible, but of common occurrence.
Andersonville seems to be head-quarters for all the
little pests that ever originated—flies by the thousand
millions. I have got into one bad scrape, and the one
thing now is to get out of it. Can do nothing but take
as good care of myself as possible, which I do.
Battese works all the time at something. Has
scrubbed his hands sore, using sand for soap.
June 14.—Mike Hoare stalks around, cheerful,
black and hungry. We have long talks about our
school days when little boys together. Mike is a
mason by trade, and was solicited to go out and work
for the rebels. Told them he would work on nothing
but vaults to bury them in. Is a loyal soldier and had
rather die here than help them, as, indeed, would a
majority of the prisoners. To tell the truth, we are so
near death and see so much of it, that it is not
dreaded as much as a person would suppose. We
stay here day after day, week after week, and month
after month, seemingly forgotten by all our friends at
the North, and then our sufferings are such that
death is a relief in the view of a great many, and not
dreaded to any extent. By four o’clock each day the
row of dead at the gate would scare the life out of me
before coming here, while now it is nothing at all, but
the same thing over and over.
June 15.—I am sick; just able to drag around. My
teeth are loose, mouth sore, with gums grown down
in some places lower than the teeth and bloody, legs
swollen up with dropsy and on the road to the
trenches. Where there is so much to write about, I
can hardly write anything. It’s the same old story and
must necessarily be repetition. Raiders now do just
as they please, kill, plunder and steal in broad
daylight, with no one to molest them. Have been
trying to organize a police force, but cannot do it.
Raiders are the stronger party. Ground covered with
maggots. Lice by the fourteen hundred thousand
million infest Andersonville. A favorite game among
the boys is to play at odd or even, by putting their
hand inside some part of their clothing, pull out what
they can conveniently get hold of and say “odd or
even?” and then count up to see who beats. Think
this is an original game here, never saw it at the
North. Some of the men claim to have pet lice which
they have trained. Am gradually growing worse.
Nothing but the good care I have taken of myself has
saved me thus far. I hope to last some time yet, and
in the meantime relief may come. My diary about
written through. It may end about the same time I do,
which would be a fit ending.
June 16.—Old prisoners (some of them) will not
credit the fact that there is plenty to eat at the North.
They think because we are starved here, that it is so
all over. They are crazy (as you may say) on the
subject of food, and no wonder. In our dreams we
see and eat bountiful repasts, and awake to the other
extreme. Never could get a chance to talk with Capt.
Wirtz, as he comes inside no more. Probably just as
well. Is a thoroughly bad man, without an atom of
humanity about him. He will get killed, should we
ever be released, as there are a great many here
who would consider it a christian duty to rid the earth
of his presence. Disease is taking right hold of me
now. Battese is an angel; takes better care of me
than of himself. Although not in our mess or tent, he
is nearly all the time with us. It is wonderful the
powers of endurance he has. I have always been
blessed with friends, and friends, too, of the right
sort. Had quite a talk with Dorr Blakeman, a Jackson,
Mich., boy. Was not much acquainted with him at
home but knew his people. Is a thoroughly good
fellow, and a sensible one. It is a relief to see any
one who does not lose his head.
June 17.—Must nurse my writing material. A New
York Herald in camp, which says an exchange will
commence the 7th of July. Gen. Winder is on a visit
to Andersonville. Is quite an aged man, and white
haired. Very warm and almost suffocating. Seems as
if the sun was right after us and belonged to the
Confederacy. Chas. Humphrey, of Massachusetts,
who has been in our hundred for months, has gone
crazy; wanders about entirely naked, and not even a
cap on his head. Many of the prisoners are crazy,
and I only speak of those in our immediate proximity.
Am in good spirits, notwithstanding my afflictions.
Have never really thought yet that I was going to die
in this place or in the Confederacy. Saw a newcomer
pounded to a jelly by the raiders. His cries for relief
were awful, but none came. Must a few villains live at
the expense of so many? God help us from these
worse than rebels.
June 18.—Have now written two large books full;
have another at hand. New prisoners who come here
have diaries which they will sell for a piece of bread.
No news to-day. Dying off as usual—more in
numbers each day as the summer advances. Rebels
say that they don’t begin to have hot weather down
here until about August. Well, it is plain to me that all
will die. Old prisoners have stood it as long as they
can, and are dropping off fast, while the new ones go
anyhow. Some one stole my cap during the night. A
dead neighbor furnished me with another, however.
Fast as the men die they are stripped of their clothing
so that those alive can be covered. Pretty hard, but
the best we can do. Rebels are anxious to get hold of
Yankee buttons. “Buttons with hens on,” they enquire
for. An insult to the American Eagle—but they don’t
know any better.
June 19.—A young fellow named Conely tramps
around the prison with ball and chain on. His crime
was trying to get away. I say he tramps around, he
tramps away from the gate with it on at nine in the
morning, and as soon as out of sight of the rebels he
takes it off, and only puts it on at nine o’clock the
next morning to report at the gate duly ironed off.
They think, of course, that he wears it all the time.
Jimmy Devers looks and is in a very bad way. Too
bad if the poor fellow should die now, after being a
prisoner almost a year. Talks a great deal about his
younger brother in Jackson, named Willie. Says if he
should die to be sure and tell Willie not to drink,
which has been one of Jimmy’s failings, and he sees
now what a foolish habit it is. Michael Hoare stands it
well. When a man is shot now it is called being
“parolled.”
June 20.—All the mess slowly but none the less
surely succumbing to the diseases incident here. We
are not what you may call hungry. I have actually felt
the pangs of hunger more when I was a boy going
home from school to dinner. But we are sick and faint
and all broken down, feverish &c. It is starvation and
disease and exposure that is doing it. Our stomachs
have been so abused by the stuff called bread and
soups, that they are diseased. The bread is coarse
and musty. Believe that half in camp would die now if
given rich food to eat.
June 21.—I am a fair writer, and am besieged by
men to write letters to the rebel officers praying for
release, and I do it, knowing it will do no good, but to
please the sufferers. Some of these letters are
directed to Capt. Wirtz, some to Gen. Winder, Jeff
Davis and other officers. As dictated by them some
would bring tears from a stone. One goes on to say
he has been a prisoner of war over a year, has a wife
and three children destitute, how much he thinks of
them, is dying with disease, etc., etc. All kinds of
stories are narrated, and handed to the first rebel
who comes within reach. Of course they are never
heard from. It’s pitiful to see the poor wretches who
think their letters will get them out, watch the gate
from day to day, and always disappointed. Some one
has much to answer for.
June 22.—The washing business progresses and
is prosperous. One great trouble is, it is run too loose
and we often get no pay. Battese, while a good
worker, is no business man, and will do anybody’s
washing on promises, which don’t amount to much.
Am not able to do much myself, principally hanging
out the clothes; that is, laying the shirt on one of the
tent poles and then watching it till dry. All day
yesterday I lay under the “coverlid” in the shade,
hanging on to a string which was tied to the washing.
If I saw a suspicious looking chap hanging around
with his eyes on the washed goods, then gave a
quick jerk and in she comes out of harm’s way.
Battese has paid for three or four shirts lost in this
way, and one pair of pants. Pays in bread. A great
many Irish here, and as a class, they stand hardships
well. Jimmy Devers losing heart and thinks he will
die. Capt. Wirtz has issued another order, but don’t
know what it is—to the effect that raiding and killing
must be stopped, I believe. Being unable to get
around as I used to, do not hear the particulars of
what is going on, only in a general way. New men
coming in, and bodies carried out. Is there no end but
dying?
June 23.—My coverlid nobly does duty, protecting
us from the sun’s hot rays by day and the heavy
dews at night. Have no doubt but it has saved my life
many times. Never have heard anything from
Hendryx since his escape. Either got away to our
lines or shot. Rebels recruiting among us for men to
put in their ranks. None will go—yes, I believe one
Duffy has gone with them. Much fighting. Men will
fight as long as they can stand up. A father fights his
own son not ten rods from us. Hardly any are strong
enough to do much damage except the raiders, who
get enough to eat and are in better condition than the
rest. Four or five letters were delivered to their
owners. Were from their homes. Remarkable, as I
believe this is the first mail since our first coming
here. Something wrong. Just shake in my boots—
shoes, I mean, (plenty of room) when I think what
July and August will do for us. Does not seem to me
as if any can stand it. After all, it’s hard killing a man.
Can stand most anything.
June 24.—Almost July 1st, when Jimmy Devers
will have been a prisoner of war one year. Unless
relief comes very soon he will die. I have read in my
earlier years about prisoners in the revolutionary war,
and other wars. It sounded noble and heroic to be a
prisoner of war, and accounts of their adventures
were quite romantic; but the romance has been
knocked out of the prisoner of war business, higher
than a kite. It’s a fraud. All of the “Astor House Mess”
now afflicted with scurvy and dropsy more or less,
with the exception of Battese, and myself worst of
any. Am fighting the disease, however, all the time,
and the growth is but slight. Take exercise every
morning and evening, when it is almost impossible
for me to walk. Walk all over before the sun comes
up, drink of Battese’s medicine made of roots, keep
clear of vermin, talk and even laugh, and if I do die, it
will not be through neglect. Carpenter, the teamster
who sold me the boots, is about gone, and thank the
Lord he has received his sixty cents from me, in
rations. Sorry for the poor fellow. Many who have all
along stood it nobly now begin to go under. Wm. B.
Rowe, our tall mess-mate, is quite bad off, still, he
has an iron constitution and will last some time yet.
June 25.—Another lead pencil wore down to less
than an inch in length, and must skirmish around for
another one. New men bring in writing material and
pencils. To-day saw a New York Herald of date June
11th, nothing in it about exchange, however. That is
all the news that particularly interests us, although
accounts of recent battles are favorable to the Union
side. Our guards are composed of the lowest
element of the South—poor white trash. Very
ignorant, much more so than the negro. Some of
them act as if they never saw a gun before. The rebel
adjutant does quite a business selling vegetables to
those of the prisoners who have money, and has
established a sutler stand not very far from our mess.
Hub Dakin, an old acquaintance, is a sort of clerk,
and gets enough to eat thereby. Hot! Hot! Raiders kill
some one now every day. No restraint in the least.
Men who were no doubt respectable at home, are
now the worst villains in the world. One of them was
sneaking about our quarters during the night, and
Sanders knocked him about ten feet with a board.
Some one of us must keep awake all the time, and
on the watch, fearing to loose what little we have.
June 26.—The same old story, only worse, worse.
It seems all the time it was as bad as could be, but is
not. They die now like sheep—fully a hundred each
day. New prisoners come inside in squads of
hundreds, and in a few weeks are all dead. The
change is too great and sudden for them. Old
prisoners stand it the best. Found a Jackson,
Michigan man, who says I am reported dead there.
Am not, however, and may appear to them yet.
Jimmy Devers is very bad with the scurvy and dropsy
and will probably die if relief does not come. Sergt.
Rowe also is afflicted; in fact all the mess except
Battese. He does all the cooking now. He has made
me a cane to walk with, brings water from the well,
and performs nearly all the manual labor for us. He is
a jewel, but a rough one.
June 27.—Raiders going on worse than ever
before. A perfect pandemonium. Something must be
done, and that quickly. There is danger enough from
disease, without being killed by raiders. Any moment
fifty or a hundred of them are liable to pounce upon
our mess, knock right and left and take the very
clothing off our backs. No one is safe from them. It is
hoped that the more peaceable sort will rise in their
might and put them down. Our misery is certainly
complete without this trouble added to it. We should
die in peace anyway. Battese has called his Indian
friends all together, and probably a hundred of us are
banded together for self protection. The animal
predominates. All restraint is thrown off and the very
Old Harry is to pay. The farther advanced the
summer, the death rate increases, until they die off
by scores. I walk around to see friends of a few days
ago and am told “dead.” Men stand it nobly and are
apparently ordinarily well, when all at once they go.
Like a horse, that will stand up until he drops dead.
Some of the most horrible sights that can possibly
be, are common every day occurrances. See men
laying all around in the last struggles.
June 28.—It seems to me as if three times as
many as ever before are now going off, still I am told
that about one hundred and thirty die per day. The
reason it seems worse, is because no sick are being
taken out now, and they all die here instead of at the
hospital. Can see the dead wagon loaded up with
twenty or thirty bodies at a time, two lengths, just like
four foot wood is loaded on to a wagon at the North,
and away they go to the grave yard on a trot.
Perhaps one or two will fall off and get run over. No
attention paid to that; they are picked up on the road
back after more. Was ever before in this world
anything so terrible happening? Many entirely naked.
June 29.—Capt. Wirtz sent inside a guard of fifteen
or twenty to arrest and take out quite a number of
prisoners. They had the names and would go right to
their quarters and take them. Some tell-tale traitor
has been informing on them, for attempting to
escape or something. Wirtz punishes very hard now;
so much worse than a few months ago. Has
numerous instruments of torture just outside the
gate. Sores afflict us now, and the Lord only knows
what next. Scurvy and scurvy sores, dropsy, not the
least thing to eat that can be called fit for any one,
much less a sick man, water that to drink is poison,
no shelter, and surrounded by raiders liable to cut our
throats any time. Surely, this is a go. Have been
reading over the diary, and find nothing but grumbling
and growlings. Had best enumerate some of the
better things of this life. I am able to walk around the
prison, although quite lame. Have black pepper to
put in our soups. Am as clean perhaps as any here,
with good friends to talk cheerful to. Then, too, the
raiders will let us alone until about the last, for some
of them will get killed when they attack the “Astor
House Mess.” Am probably as well off as any here
who are not raiders, and I should be thankful, and am
thankful. Will live probably two or three months yet.
“If t’weren’t for hope the heart would break,” and I am
hopeful yet. A Pennsylvanian of German descent,
named Van Tassel, and who has “sorter identified
himself with us” for two or three months, died a few
moments ago. The worst cases of the sick are again
taken to the hospital—that is, a few of the worst
cases. Many prefer to die among their friends inside.
Henry Clayton also died to-day. Was at one time in
charge of our Division, and an old prisoner. Mike
Hoare still hangs on nobly, as also do many other of
my friends and acquaintances. Dorr Blakeman
stands it unusually well. Have had no meat now for
ten days; nothing but one-third of a loaf of corn bread
and half a pint of cow peas for each man, each day.
Wood is entirely gone, and occasionally squads
allowed to go and get some under guard. Rowe went
out to-day, was not able to carry much, and that had
to be divided between a hundred men. One of the
most annoying things is being squadded over every
few days, sick and all. It’s an all day job, and have to
stand out until we are all tired out, never getting any
food on these days.
June 30.—A new prisoner fainted away on his
entrance to Andersonville and is now crazy, a raving
maniac. That is how our condition affected him. My
pants are the worse for wear from repeated
washings, my shirt sleeveless and feet stockingless;
have a red cap without any front piece; shoes by
some hocus-pocus are not mates, one considerable
larger than the other. Wonder what they would think if
I should suddenly appear on the streets in Jackson in
this garb. Would be a circus; side show and all. But
nights I have a grand old coverlid to keep off the wet.
Raiders steal blankets and sell to the guards, which
leaves all nearly destitute of that very necessary
article. Often tell how I got my coverlid, to visitors.
Have been peddling pea soup on the streets: “Ten
cents in money or a dollar Confed for this rich soup!
Who takes it?” And some wretch buys it. Anything in
the way of food will sell, or water, if different from
swamp water. Rebs making a pretense of fixing up
sanitary privileges at the swamp, which amount to
nothing. Strong talk of forming a police force to put
down raiders and to enforce order. If successful it will
prove of great benefit. Sanders, Rowe, Blakeman,
Dakin and myself are among those who will take an
active part, although the part I take cannot be very
active. Half a dozen letters sent inside to prisoners,
but no news in them that I can hear of. More hot and
sultry, with occasional rains. The crazy man says
nothing but “prayer” will save us. He has been
sucking a bone now for about two weeks and pays
more attention to that than to prayer.
July 1.—Matters must approach a crisis pretty
soon with the raiders. It is said that even the rebels
are scared and think they will have no prisoners,
should an exchange ever occur. John Bowen, a
Corp. Christency, Hemmingway, Byron Goodsell and
Pete Smith, old acquaintances, have all died within a
few days. Jimmy Devers still lives, with wonderful
tenacity to life. To-morrow he will have been a
prisoner of war a year. Mike Hoare still keeps very
well, but the most comical looking genius in the
whole prison. Could make a fortune out of him on
exhibition at the North. He says I look worse
however. That may be, but not so comical. It’s
tragedy with the most of us. New guards are taking
the place of the old ones, and it is said that Wirtz is
going away. Hope so. Never have heard one word
from Hendryx since his getting away. Sanders is
trying to get outside as a butcher. He understands
the business. “Dad” has been to Australia, and has
told us all about that country. Have also heard all
about Ireland and Scotland. Should judge they were
fine countries. Rowe has been telling me of the
advantage of silk under clothing, and in addition to
visiting all the foreign countries, we shall have silk
under wear. Rowe once lived in Boston, and I shall
likewise go there.

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A01_BERK3278_04_SE_FM.indd 7 6/11/16 9:07 PM

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Part 4 Risk and Return Chapter 11 Optimal Portfolio Choice

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The Security Market Line 390 12.7 Final Thoughts on Using

A01_BERK3278_04_SE_FM.indd 10 6/11/16 9:07 PM

A01_BERK3278_04_SE_FM.indd 11 6/11/16 9:07 PM

Growth and Debt 541 Reduction of Wasteful Investment 572

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MyFinanceLab 630 n Key Terms 631 n

Chapter 18 Capital Budgeting and ­ MyFinanceLab 674 n Key Terms 676 n

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Expansion 695 20.3 Put-Call Parity 736

Further Reading 751 n Problems 751 n

Chapter 20 Financial Options 724 21.3 Risk-Neutral Probabilities 776

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Agency Costs of Debt 785 Venture Capital Investing 834

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Chapter 25 Leasing 889 26.4 Payables Management 927

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Part 10 Special Topics Chapter 29 Corporate Governance 993

29.2 Monitoring by the Board of ­Directors

28.3 Reasons to Acquire 966 29.3 Compensation Policies 998

28.5 Takeover Defenses 978 29.6 Corporate Governance Around

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30.2 Commodity Price Risk 1024 31.2 Valuation of Foreign Currency

A01_BERK3278_04_SE_FM.indd 18 6/11/16 9:07 PM

The Law of One Price as the Unifying

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with questions designed to guide students’ analysis. Many Market-to-Book Ratio

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Peter DeMarzo is the Mizuho Financial Group Professor of

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New to This Edition

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THE ASTOR HOUSE MESS STILL HOLDS TOGETHER, ALTHOUGH

June 8.—More new prisoners. There are now over

June 11.—And so has ended a really colossal

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Part 4 Risk and Return Chapter 11 Optimal Portfolio Choice

The Security Market Line 390 12.7 Final Thoughts on Using

Chapter 18 Capital Budgeting and MyFinanceLab 674 n Key Terms 676 n

29.2 Monitoring by the Board of Directors

28.5 Takeover Defenses 978 29.6 Corporate Governance Around

30.2 Commodity Price Risk 1024 31.2 Valuation of Foreign Currency